Trade Negotiations - Who Has Control? Trump Or China?

Big Rally On Tuesday On Partial Tariff Removal

Stocks rallied sharply on Tuesday as the market seems to be trendless; stocks take 2 steps forward and 2 steps back. A down day may have brought the market to new corrections lows. That was avoided because Trump delayed some of the tariffs. As I will describe later in this article, America removed some items on the list of goods expected to be tariffed starting on September 1st. This is the $300 billion tranche of goods that will be taxed at a 10% rate.

This is a good sign, but it probably doesn’t mean the trade war is over. If anything, it could mean the trade war will continue longer because the tariffs are more sustainable. The more damage tariffs do, the less likely they are to stick. With some consumer goods taken off the list, it means the tariffs might stick for a few more months.

Specifics Of Tuesday’s Action

Specifically, the S&P 500 rallied 1.48% pushing it towards the middle of its recent range. The top end of the range is the record high and the bottom end is the correction low. The market is waiting for clarification on tariffs, geopolitics, the economy, and monetary policy. There is uncertainty everywhere you look. The Nasdaq increased 1.95% and the Russell 2000 increased 1.09%. It’s tough for the Russell 2000 to outperform with the financials being weighed down by the flattening yield curve.

The VIX fell 16.93% which brought it to 17.52. It has been hovering between the high teens and the low 20s for a while. The CNN fear and greed index finally exited extreme fear as it increased 4 points to 27 which is fear. On Monday all S&P 500 sectors fell and on Tuesday all sectors rose. The 3 best sectors were technology, consumer discretionary, and communication services which increased 2.47%, 1.67%, and 1.5%.

Treasury Curve Flattens Further

Once again, the treasury market is in focus. The CPI report and tariff news affected the treasury market. The 30 year yield increased slightly, so it didn’t hit a new record low. With it being at 2.15%, it needs to fall just over 6 basis points to surpass the July 2016 low. The 10 year 2 year spread is intriguing because it continues to shrink. The difference between the two at one point hit 2 basis points. It’s now at 4 basis points as the 2 year yield is at 1.63% and the 10 year yield is at 1.67%.

The CPI report and the trade policy change caused the odds of a 50 basis point cut in September to fall, flattening the curve. The chance of a double cut fell from 15.4% to 5%. There was recently about a 50% chance of at least 3 more rate cuts this year and now it’s at 38.4%. The most likely action moved from 3 more cuts to 2 more cuts. This change in rate cut odds explains the near inversion.

Now that hardly anything needs to change for an inversion to occur, we can focus on how each Fed choice effects the odds of a recession. Even though the treasury curve shows one is coming as early as 2020, I don’t see evidence of a recession yet.

Fund Managers Love Treasuries

As you can see from the chart below, in the Bank of America survey, fund managers showed in August they were the most bullish on treasuries since November 2008. A net 43% expect lower short term rates and just a net 9% expect higher long term rates in the next year. Similar results were seen in 2007 right before the previous recession. That makes sense because the curve is nearly projecting a recession itself. The NY Fed’s model, which uses the curve, probably will show close to a 40% chance of a recession in the next year when it’s updated in a couple weeks.

Trump Delays Some Tariffs

The big trade policy update is that the Trump administration is delaying the new tariffs for certain consumer items such as smartphones, laptops, video game consoles, some clothes, shoes, and certain toys until December 15th. That’s back from September 1. The delay is to mitigate the effect on the holiday shopping season. Trump stated, “We’re doing this for the Christmas season. So far, they’ve had virtually none. But just in case they might have an impact on people, what we’ve done is we’ve delayed it, so that they won’t be relevant to the Christmas shopping season.”

It’s true that the consumer hasn’t had to deal with as many tariffs as manufacturers. We were about to see their effect, but now it’s partially delayed. It’s good to see Trump is showing some hesitation towards taxing the consumer. Hopefully, there is a deal by December 15th, so these taxes never go into effect. Many are saying Trump blinked in these negotiations which is bad for his positioning. I disagree somewhat. Yes, he showed weakness. However, did anyone really think he was willing to significantly hurt the consumer in these negotiations? Neither side wants to tank their economy.

Chinese Economy Weakens Sharply In July

Even though America showed some weakness, China doesn’t have a strong hand either. The latest economic data from July was high disconcerting. As you can see from the chart below, industrial production growth was 4.8% which was the slowest pace since February 2002. Economists expected 5.8% growth; growth was 6.3% in June. Fixed asset investment growth was 5.7% in the first 7 months of the year which missed estimates for 5.8% growth.

Private sector fixed asset investment growth was 5.4% in the first 7 months of 2019 which was down from 5.7% in the first 6 months of the year. Finally, retail sales growth was 7.6% in July which missed estimates for 8.6% and June’s reading of 9.8%. This data explains why I don’t see Trump being in much weaker shape than China. Neither side is in good position. The weaker the data gets, the more likely China will negotiate in good faith with America and work on getting a deal done quickly.

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